2016-0641851E5 ECP Rules NAL Disposition

Principal Issues: In a situation where a taxpayer acquired goodwill from a NAL prior to January 1, 2017 and disposes of the goodwill after January 1, 2017 to an AL person, will the grind (originally recognized under variable A.1 in the definition of CEC in subsection 14(5) of the Act) be restored for purposes of calculating the capital gain?

Position: Under the current version of the proposed rules no.

Reasons: See analysis.

Author: Couvrette, Amanda
Section: 13(7)(e); 13(37); 13(38); 13(39); 14(1); 14(5); Schedule II of the Regulations

XXXXXXXXXX                                                                                                    Amanda Couvrette
                                                                                                                            2016-064185
June 7, 2016

Dear Mrs. XXXXXXXXXX,

Subject: Proposed Eligible Capital Property (“ECP”) Rules

We are writing in response to your recent inquiry concerning the draft legislation released as part of the 2016 federal budget (Notice of Ways and Means Motion to Amend the Income Tax Act and Other Tax Legislation - “the “NWMM”) concerning the repeal and replacement of the “eligible capital property” rules contained in section 14 of the Income Tax Act (the “Act”) with rules for a new “capital cost allowance class” (Class 14.1).

Briefly, we understand your specific concern is with the wording of proposed subsection 13(37) contained in the NWMM as it appears to apply in the following hypothetical fact situation.

Assume a taxpayer acquired an “eligible capital property” (“ECP”), as that term is defined in subsection 14(5) of the Act, from a non-arm’s length taxpayer (transferor) prior to January 1, 2017.  Under the existing ECP rules, variable A.1 in the definition of “cumulative eligible capital” (“CEC”) in subsection 14(5) will apply to reduce the amount otherwise added to the CEC pool in respect of the taxpayer’s acquisition of such property (referred to herein as the “grind”) until such time that the particular ECP is subsequently disposed of to an arm’s-length (“AL”) person.

Under the proposed transitional rules, 4/3 of the taxpayer’s CEC pool at the end of the day on December 31, 2016, essentially becomes the capital cost of the property included in new Class 14.1 at the beginning of the day on January 1, 2017.  However, when the taxpayer eventually sells the particular Class 14.1 property after January 1, 2017, the former grind to the CEC pool does not appear to be restored (i.e., added to the cost of the new Class 14.1 asset) for the purpose of computing any potential capital gain.

You are wondering how (or if) the former grind to the CEC pool should be restored under the proposed rules contained in the NWMM where such property is sold by a taxpayer after January 1, 2017 to an AL person.

Our comments

Generally speaking, proposed paragraph 13(37)(a) provides that the total capital cost of Class 14.1 at the beginning of January 1, 2017 is 4/3 of the amount that would be the CEC pool balance at the beginning of January 1, 2017; plus 4/3 of the amount of deductions taken that have not been recaptured; less 4/3 of any negative CEC pool balance at the beginning of January 1, 2017.

Based on the proposed transitional rules in the NWMM, we agree that for capital gains purposes there is no upward adjustment (for the amount of the former grind to the CEC pool) to the cost or capital cost of the Class 14.1 property where such property is sold to an AL person after January 1, 2017.

The Department of Finance is responsible for matters concerning tax policy and changes to tax legislation.  Accordingly, we have referred this matter to them for their consideration in the finalization of the proposed legislation.

We trust these comments will be of assistance.

Yours truly

Michael Cooke, C.P.A., C.A.
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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